Booker v. Commissioner

T.C. Memo. 1996-261

UNITED STATES TAX COURT

DERWYN J. BOOKER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 15366-88. Filed June 6, 1996.

Derwyn J. Booker, pro se.

Lavonne D. Lawson, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

WRIGHT, Judge: For taxable year 1984, respondent determined

a deficiency in petitioner’s Federal income tax in the amount of

$4,737 and additions to tax under section 6653(a)(1) in the

amount of $236.85, under section 6653(a)(2) for 50 percent of the
interest due on $4,737, and under section 6659 in the amount of

$459.30, and for increased interest under section 6621(c).

Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the year at issue, and

all Rule references are to the Tax Court Rules of Practice and

Procedure. The issues for decision for the taxable year 1984 are

as follows:

(1) Whether petitioner is entitled to claimed deductions

and a claimed investment tax credit in connection with a master

recording lease transaction. We hold that he is not.

(2) Whether petitioner is entitled to a claimed business

bad debt deduction in the amount of $76,056 in connection with

his investment in the Carter Co. We hold that he is not.

(3) Whether unemployment compensation petitioner received

in the amount of $5,312 is taxable as determined by respondent.

We hold that it is.

(4) Whether petitioner is subject to self-employment tax on

his self-employment income. We hold that he is.

(5) Whether petitioner is liable for an addition to tax for

negligence under section 6653(a)(1) as determined by respondent.

We hold that he is.

(6) Whether petitioner is liable for an addition to tax for

a valuation overstatement under section 6659 as determined by

respondent. We hold that he is.
 (7) Whether petitioner is liable for increased interest

under section 6621(c). We hold that he is.

(8) Whether petitioner is liable for a penalty for

maintaining a frivolous action under section 6673. We hold that

he is not.

FINDINGS OF FACT

The stipulation of facts and the attached exhibits are

incorporated herein. Petitioner resided in Toledo, Ohio, at the

time the petition was filed.

Petitioner has a bachelor of science degree in mechanical

engineering and was employed as an engineer for the Tosco Corp.

in its oil refinery at Bakersfield, California. Petitioner

received unemployment compensation in the amount of $5,312 in

1984. In 1984, after leaving Tosco, petitioner started a

business named J. Booker and Co., offering financial advice.

Encore Leasing

During 1983, petitioner investigated a number of tax

shelters before deciding to participate in the Encore Leasing Tax

Shelter Program as both an investor and a promoter. Petitioner

was the managing partner of BBG, Ltd.(BBG), which was composed of

petitioner and two other individuals. On December 27, 1984,

petitioner, acting on behalf of BBG, entered into a lease

transaction with Encore Leasing Corp. (Encore); the lease

indicates that BBG’s total investment in the program was $14,880.
It is unclear from the record the exact amount of petitioner’s

share of the initial investment in Encore.

Encore was incorporated on February 1, 1982. Encore is in

the business of leasing master recordings of previously released

pop and gospel albums. Master recordings are original recordings

of performances on audio tape used to produce disc records and

tapes for mass distribution. In 1984, Encore leased master

recordings for gospel records, educational computer programs, and

home computer games.

Clint Collings (Collings) was the president and sole

shareholder of Encore during the year at issue. Encore's

prospectus for 1984 consists of 24 pages, of which 14 pages are

cover sheets, table of contents, blank sample forms, and blank

pages. Encore's promotional material for 1984 also includes a

51-page "Tax Opinion" and an 8-page addendum addressing 1984 tax

changes both prepared by Attorney Henry D. Nunez (Nunez).

Although page 1 of the prospectus refers to an "exciting

business opportunity while taking advantage of current tax laws",

it mentions very little about said opportunity, while strongly

emphasizing the benefits derived from the investment tax credit.

The prospectus contains a letter from Mr. Nunez stating:

upon request by Encore, we will assist a lessee and
their counsel and accountants if the Internal Revenue
Service challenges the tax structure of the transaction
as set forth in the Opinion and the lessee is unable to
reach a satisfactory resolution at the initial audit
level. Such assistance would include advice in
connection with their appearances before the appellate
division of the Internal Revenue Service. We would
 also be available to assist the lessee’s counsel in
defense before the U.S. District Court, U.S. Tax Court
or the U.S. Court of Claims.

Encore's prospectus contains in substance only one page,

discussing in general terms the gospel record market, the home

computer game market, and educational computer programs. The

prospectus does not specifically address the master recordings,

the computer games, or the computer programs that Encore intends

to lease, the quality of such, nor any other facets of the Encore

program.

The “How Our Program Works” section of the prospectus is one

page in length containing four paragraphs. Three paragraphs are

devoted to the tax aspects of the program, and one paragraph

refers to the lease agreement. The remainder of the page

outlines in tables the amount of advance payment required from

the lessee and the amount of investment tax credit passed through

to the lessee. The "Financial Section" of the prospectus

contains two paragraphs and explains the investment tax credit

available with respect to the sound recordings and computer

software. There is no analysis in the prospectus of the

potential nontax, economic profitability of its leasing program.

Also, there is no information in the prospectus regarding the

marketability of the master recordings that Encore intends to

lease, nor any information concerning how master recordings can

be marketed. Petitioner had a copy of the Encore prospectus, the
tax opinion, and the lease agreement when making his investment

in Encore.

The Encore lease agreement contains a 7-year lease term and

provides that petitioner did not have an option to purchase the

master recording or to renew the lease agreement at the end of

the lease term. Encore uses a standard master recording lease

agreement which it included in all its promotional materials.

Petitioner did not modify any of the terms of the lease agreement

which he signed. From Encore’s product catalogue, petitioner

chose the master recording “Unity” by the Kingcannon family.

Before signing the lease agreement, petitioner did not listen to

the master recording, was not acquainted with the artists who

recorded the master, and had not previously listened to any of

the artists’ recordings. At no time did petitioner obtain an

independent written appraisal of the subject master recording,

nor did he obtain an independent written opinion with respect to

the profitability of entering into the Encore lease agreement.

Encore did provide petitioner with a 1-1/2-page written appraisal

dated June 24, 1985. The appraisal lists the subject master’s

value at $500,000.

Encore purchased the subject master from the Kingcannon

family through the artists’ agent, Gabriel Records. The purchase

price for the subject master was $496,000. Encore issued a check

to Gabriel Records on December 31, 1984, in the amount of $5,208

and executed a promissory note for the balance of $490,792. The
actual value of the subject master equaled between $3,000 and

$5,000.

Included in Encore’s prospectus package is a list of

distributors with respect to the distribution of sound recordings

made from the subject master recording. Petitioner entered into

a standard distribution-employment agreement with Arrival Records

and did not modify any of the terms of the agreement before

signing. Petitioner’s distribution agreement with Arrival was

subsequently assigned to Marock Records.

During the term of the lease between petitioner and Encore,

total income derived from sales of albums and cassettes made from

the Kingcannon master totaled $570.85. Petitioner’s share of the

income from sales of albums and cassettes made from the subject

master totaled $18.57. The primary purchaser of the sound

recordings made from the master was the artists, the Kingcannon

family. During the term of the lease, petitioner did not

personally distribute sound recordings made from the subject

master.

During 1984, petitioner worked as an agent for Encore

selling its tax shelters at a commission rate of 20 percent of

receipts from the sales of leases. During the latter part of

1984, petitioner issued three newsletters directed to his master

recording lease clients. Each newsletter was entitled DERWYN J.

BOOKER, TAX ADVANTAGED INVESTMENT COUNSELING.
 Petitioner received commissions from Encore in the amount of

$11,010 in 1984, and in the amount of $2,976 in 1985, with

respect to his 1984 master lease sales. Petitioner claimed

deductions in the amount of $9,164 and an investment tax credit

in the amount of $17,808 with respect to his participation in the

Encore program during 1984.

On September 12, 1986, the U.S. District Court for the

Eastern District of California permanently enjoined Mr. Collings,

as shareholder and president of Encore, from taking any action in

furtherance of the organization, promotion, advertising,

marketing, selling or offering for sale, any new or future

interest in the Encore master recording lease programs.

The Carter Company

Petitioner entered into an investment agreement with the

Carter Co. (Carter) on January 4, 1983. Carter held itself out

to potential investors as a company engaged in the medical

factoring business, purchasing medical accounts receivable and

insurance claims from doctors at a discounted rate. Petitioner

did advance funds to Carter under the investment agreement.

Petitioner claims to have contributed a total of $76,050,

however; the record is not clear as to the precise amount of

petitioner's investment. No security or collateral was given for

petitioner’s advances to Carter. Carter issued promissory notes

to petitioner in exchange for his contribution. Carter made

quarterly payments to its investors at a rate of 7 to 10 percent
on their investment. Carter investors had the option of taking

their quarterly payments or electing to have the funds rolled

over into another promissory note. Petitioner involved several

of his investment clients, including friends and relatives, in

Carter. Petitioner and his clients regularly elected to reinvest

their quarterly interest payments. Carter made no payments on

any of the notes at issue.

An investigation, conducted by the Securities and Exchange

Commission in 1983, revealed that Carter did not represent any

doctors, had no medical accounts receivable, and was not engaged

in the medical factoring business. Carter filed a petition in

bankruptcy in the U.S. Bankruptcy Court for the Central District

of California under chapter 11 of the Bankruptcy Code on December

8, 1983. In 1990, the proceeding was converted to a chapter 7

bankruptcy proceeding. In 1992, petitioner received a payment

representing some percentage of his total investment in Carter as

a result of the bankruptcy proceeding.

Petitioner claimed a deduction on Schedule C of his 1984

income tax return in the amount of $76,056 for “bad notes” with

respect to his dealings with Carter. Respondent disallowed the

claimed deduction on the basis that it was not a bona fide debt

within the meaning of section 166.
 OPINION

Issue 1. Encore

Section 162 allows a deduction for ordinary and necessary

expenses paid or incurred during the taxable year in carrying on

a trade or business. In order to establish entitlement to

deductions and credits, taxpayers have the burden of proving that

they meet the statutory requisites. New Colonial Ice Co. v.

Commissioner, 292 U.S. 435 (1934).

Section 38 allows a credit for investment in certain

depreciable property. The amount of the credit is limited to a

percentage of a taxpayer’s qualified investment in section 38

property. Sec. 46(a). Qualified investment in new property is a

percentage of the property’s basis, generally its cost. Secs.

46(c)(1), 1012. The lessor of the property, here Encore, may

elect to pass through the credit to the lessee, here petitioner,

and the lessee generally is treated as having acquired the

property for its fair market value. Sec. 48(d).

In Mahoney v. Commissioner, 808 F.2d 1219 (6th Cir. 1987),

affg. 85 T.C. 127 (1985), the Court of Appeals for the Sixth

Circuit, where an appeal of the instant case would lie,

determined that in order to be valid, a transaction giving rise

to asserted deductions must satisfy both components of a two-

prong test. See also Pasternak v. Commissioner, 990 F.2d 893

(6th Cir. 1993), affg. Donahue v. Commissioner, T.C. Memo. 1991-

181; Rose v. Commissioner, 868 F.2d 851 (6th Cir. 1989), affg. 88
T.C. 386 (1987). First, the transaction must have economic

substance; the transaction cannot be a complete sham. Mahoney v.

Commissioner, supra at 1219. Second, if the transaction is found

to have economic substance, the question becomes whether the

taxpayer was motivated by profit to participate in the

transaction within the meaning of section 183. Id. If the

transaction is found to be a sham, then the entire transaction is

disregarded for Federal income tax purposes, and such niceties as

whether the transaction was engaged in primarily for profit are

simply not involved. Id. Therefore, in determining whether a

particular transaction was a sham, a court should not address

whether, in the light of hindsight, the taxpayer made a wise

investment; instead, the court must address whether the taxpayer

made a bona fide investment at all or whether the taxpayer merely

purchased tax deductions. Bryant v. Commissioner, 928 F.2d 745,

749 (6th Cir. 1991), affg. in part and revg. in part T.C. Memo.

1989-527.

The same two-part test is applied in determining whether a

deduction or credit with respect to investment in a tax shelter

is valid. Illes v. Commissioner, 982 F.2d 163 (6th Cir. 1992),

affg. T.C. Memo. 1991-449. A tax shelter can be reasonably

defined as a transaction entered into for the purpose of

generating (1) deductions in excess of investment contributions

claimed in a given taxable year to reduce income from other

sources that year, and/or (2) credits in excess of the tax
attributable to the income from the investment claimed in a given

taxable year to offset taxes on income from other sources that

year.

In the tax shelter line of cases, the Court of Appeals for

the Sixth Circuit has held that a transaction is a sham if it has

no practicable economic effects other than the creation of income

tax losses. Pasternak v. Commissioner, supra; Illes v.

Commissioner, supra. The first prong of the Mahoney test

requires an examination of the transaction, not the taxpayer.

Illes v. Commissioner, supra at 165. A taxpayer’s alleged

reasonable belief that his or her investment in a tax shelter had

economic substance does not preclude treatment of the transaction

as a sham. Id.

Thus, our first inquiry is whether the master recording

lease transaction entered into between Encore and petitioner had

economic substance or whether it was a sham. Several factors

have been used to determine whether a transaction has economic

substance. One such factor is evidence that the transaction was

marketed as a tax shelter generating little revenue. See

Pasternak v. Commissioner, supra at 901. Encore’s 24-page

prospectus focuses primarily on the tax advantages of investing

in the Encore program and contains only a brief description of

the recording industry. The prospectus does not describe the

specific master recordings Encore intended to lease, or the

nontax, economic profitability of Encore’s leasing program. The
obvious focus of the promotional materials distributed to

petitioner was on the attendant tax benefits of the lease

program. The tax opinion petitioner received with the

promotional materials was twice as long as the prospectus itself

and specifically raised the likelihood of prospective Internal

Revenue Service (IRS) challenge and possible litigation in the

Tax Court. Furthermore, very little revenue was generated from

sales of sound recordings made from the subject master. Indeed,

petitioner’s share of the income from sales of albums and

cassettes made from the subject master in 1984 totaled only

$18.57. Nonetheless, petitioner claimed nearly $27,000 in

deductions and investment tax credits in 1984 relating to the

master lease transaction.

Reliance on an inflated value of the master recording is

another factor considered in determining whether the underlying

transaction has economic substance. Independent Elec. Supply,

Inc. v. Commissioner, 781 F.2d 724, 728 (9th Cir. 1986), affg.

T.C. Memo. 1984-472, cited with approval in Pasternak v.

Commissioner, supra at 900. Disparity between the prices of the

master recordings and their actual fair market values is yet

another factor in determining whether transactions are shams.

Hunt v. Commissioner, 938 F.2d 466, 472 (4th Cir. 1991), cited

with approval in Pasternak v. Commissioner, supra at 900.

Encore valued the subject master leased by petitioner at

$496,000 and subsequently provided petitioner with a 1-1/2-page
appraisal listing the master’s value at $500,000. Mr. Tirk,

respondent’s expert witness, has been in the record business for

36 years in various positions including manufacturer,

distributor, wholesaler, retailer, and executive vice president

and owner of his own record company. Mr. Tirk’s valuation is

based upon many factors including the slight market for the

particular music involved, the limited number of retail outlets

that carry that type of music, the improbability of generating

any sales from exploitation of the product, petitioner’s complete

lack of experience in the industry, the relative obscurity of the

artists involved, and the poor quality of the master. Mr. Tirk

valued the subject master at $3,000 to $5,000.

The manner in which the lessee carried on his or her

activities can also be evidence of a lack of economic substance.

Pasternak v. Commissioner, supra at 900-901. Petitioner blindly

signed the form lease, failing to negotiate any of the lease

terms, and purchased no insurance on the master although the

master was purportedly worth $496,000. Petitioner did not obtain

an independent appraisal with respect to either the value of the

subject master or the possibility of making a profit with the

master. Furthermore, petitioner neither listened to the master

nor determined the quality of the master before signing the lease

agreement.

Assuming that petitioner had a one-third interest in BBG,

his share of the initial contribution amount advanced to Encore
in 1984 under the lease equaled $4,960, although he claimed

deductions and investment tax credits in an amount exceeding

$27,000. The tax benefits petitioner claimed immediately were

several times as much as the so-called investment, and little

revenue was ever produced.

The illusory nature of the financing of the lease

transaction is another factor suggesting lack of economic

substance. Rose v. Commissioner, 88 T.C. at 422. Consistent

with the tax-motivated nature of the subject transaction is the

structure of the financing of the Encore lease with large

commercially unreasonable deferred indebtedness which was very

unlikely to ever be paid. The debt was unlikely to ever be paid

because little or no revenues were likely to be received. All

future lease payments were to come from a share of the profits

earned on the sale of the recordings deferring the bulk of the

consideration by promissory notes, nonrecourse in form and

substance.

Based upon the foregoing, the record in the instant case

convinces us that the lease transaction entered into between

petitioner and Encore is devoid of economic substance. It is

apparent from the nature of the lease transaction that the Encore

lease package was marketed and sold to petitioner as a tax

shelter. As we have determined that the subject lease

transaction is devoid of economic substance, we need not address

the issue of profit motive. Accordingly, the lease transaction
does not give rise to any deductions or investment tax credits.

Respondent is sustained on this issue.

Issue 2. Carter

Section 166(a) allows a deduction for any debt which becomes

worthless within the taxable year. The deduction is allowable

only in respect of a bad debt owed to the taxpayer. Sec. 1.166-

1(a), Income Tax Regs. A bona fide debt is a debt arising from a

debtor-creditor relationship based upon a valid and enforceable

obligation to pay a fixed or determinable sum of money. Sec.

1.166-1(c), Income Tax Regs. Petitioner bears the burden of

proving, first, that a bona fide debt existed, and second, that

it became worthless in 1984. Rule 142(a); Crown v. Commissioner,

77 T.C. 582 (1981).

In determining whether a debtor-creditor relationship

represented by a bona fide debt exists, the Court considers the

facts and circumstances. Fisher v. Commissioner, 54 T.C. 905,

909 (1970). The test in making such a determination is whether

the debtor is under an unconditional obligation to repay the

creditor and whether the creditor intends to enforce repayment of

the obligation. Id. at 909-910; sec. 1.166-1(c), Income Tax

Regs. The objective indicia of a bona fide debt include whether

a note or other evidence of indebtedness existed and whether

interest was charged. See Clark v. Commissioner, 18 T.C. 780,

783 (1952), affd. 205 F.2d 353 (2d Cir. 1953). Also considered

are the existence of security or collateral, the demand for
repayment, records that may reflect the transaction as a loan,

and the borrower's solvency at the time of the loan. See Road

Materials, Inc. v. Commissioner, 407 F.2d 1121 (4th Cir. 1969),

affg. in part, vacating in part, and remanding T.C. Memo.

1967-187; Jewell Ridge Coal Corp. v. Commissioner, 318 F.2d 695,

699 (4th Cir. 1963), affg. T.C. Memo. 1962-194.

Petitioner did not provide sufficient evidence indicating

the existence of a bona fide debt. The record clearly indicates

that petitioner entered into an investment agreement with Carter.

A contribution to capital is not a debt within the meaning of

section 166. Raymond v. United States, 511 F.2d 185, 189 (6th

Cir. 1975); Hambuechen v. Commissioner, 43 T.C. 90, 99-100

(1964); sec. 1.166-1(c), Income Tax Regs. Petitioner himself

characterized his involvement with Carter as an investment in a

highly speculative business which he believed had the potential

for great rewards. Although promissory notes were issued to

petitioner in connection with the advances, no repayments were

ever made with respect to the notes, and petitioner did not

demand such repayments. Additionally, no security or collateral

was ever offered in exchange for petitioner’s advances to Carter.

We find that petitioner’s advances to Carter can fairly be

characterized as investments and not as debt within the meaning

of section 166.

As a result of petitioner’s failure to prove the existence

of bona fide debt, we need not consider whether the “debt" became
worthless in 1984. Accordingly, we find that petitioner is not

entitled to a bad debt deduction in taxable year 1984.

Respondent's determination is sustained on this issue.

Petitioner argues in the alternative that he is entitled to

deduct the loss on his investment in Carter as a theft loss for

1984. Respondent argues otherwise. Section 165 allows as a

deduction a theft loss sustained during the taxable year and not

compensated for by insurance or otherwise. Sec. 165(a), (c)(3).

Section 165(e) provides that the deduction for such loss shall be

treated as sustained in the taxable year in which the taxpayer

discovered the loss. Sec. 1.165-8(a)(2), Income Tax Regs.

Petitioner bears the burden of proving a loss by theft, the

amount of the loss, and the year in which the loss was

discovered. Rule 142(a).

Petitioner has not met his burden of proving either the

amount of the alleged theft loss or the year in which the loss

was discovered. Accordingly, based upon the record in the

instant case, we find that petitioner has not provided sufficient

evidence to establish his entitlement to a theft loss under

section 165 for taxable year 1984.

Issue 3. Unemployment Compensation

Petitioner received unemployment compensation in the amount

of $5,312 in 1984. Section 85(a) provides that if the sum of a

taxpayer’s adjusted gross income and the taxpayer’s unemployment

compensation is greater than the “base amount”, then the amount
of unemployment compensation includable in gross income is equal

to the lesser of one-half of the amount of the excess of such sum

over the base amount, or the amount of the unemployment

compensation. Petitioner’s base amount equals $12,000. See sec.

85(b)(1). Petitioner argues that the unemployment compensation

he received is not taxable under section 85 because his adjusted

gross income in 1984 fell below his base amount of $12,000.

Our determination that petitioner is not entitled to any

deductions or an investment tax credit with respect to his

dealings with Encore and that he is not entitled to a business

bad debt deduction in connection with Carter results in an upward

adjustment in petitioner’s adjusted gross income for 1984,

bringing him over the base amount of $12,000. Accordingly, the

$5,312 petitioner received in unemployment compensation is

includable in his gross income for 1984. We sustain respondent’s

determination on this issue.

Issue 4. Self-Employment Tax

Section 1401 imposes a self-employment tax on the self-

employment income of every individual. Individuals whose net

self-employment income equals or exceeds $400 during the taxable

year are required to report such income. Sec. 6017. Petitioner

argues that his net self-employment income did not exceed $400 in

1984. We have determined, however, that petitioner is not

entitled to various claimed deductions, causing petitioner’s net
self-employment income to be greater than $400 in taxable year

1984. Accordingly, respondent is sustained on this issue.

Issue 5. Negligence

Section 6653(a)(1) provides for an addition to tax equal to

5 percent of any underpayment if any part of the underpayment is

due to negligence or intentional disregard of rules and

regulations. Negligence is defined as a lack of due care or the

failure to act as a reasonable person would act under similar

circumstances. Neely v. Commissioner, 85 T.C. 934, 947 (1985).

Petitioner bears the burden of proving that no part of the

underpayment for the year at issue is due to negligence or

intentional disregard of rules and regulations. Rule 142(a);

Bixby v. Commissioner, 58 T.C. 757 (1972).

Petitioner argues that he did not rely on the

representations made by Encore in determining whether to enter

into the lease transaction. Petitioner contends that he sought

the professional advice of a number of individuals with respect

to his investment in Encore and determined that Encore had a good

reputation, that the tax advantages claimed by Encore were

supported by law, and that the masters were of marketable

quality. Petitioner argues that he did what a reasonable person

would have done under the circumstances.

Petitioner had no experience in the record industry prior to

his involvement with Encore. Petitioner was unfamiliar with the

recording artists and failed to seek an independent appraisal of
either the master’s value or its potential for profit.

Petitioner did not listen to the master or determine its quality

before signing the master recording lease. Petitioner argues

that he sought and relied upon the advice of several people in

the record industry. While petitioner did casually elicit

information from several individuals, petitioner failed to

provide sufficient evidence indicating that he sought the advice

of a professional investment counselor. The record indicates

that petitioner primarily contacted Encore promoters and

individuals at the various distribution companies connected with

Encore. Investors cannot escape the negligence penalty by

relying on the advice of persons who are not professional

investment counselors. Pasternak v. Commissioner, 990 F.2d at

903; Rybak v. Commissioner, 91 T.C. 524, 565 (1988).

We find that a reasonably prudent person would have sought

the advice of an independent tax adviser in a situation such as

this where the return is immediately several times as much as the

initial investment. See Pasternak v. Commissioner, supra at 903;

McCrary v. Commissioner, 92 T.C. 827, 850 (1989); Harris v.

Commissioner, T.C. Memo. 1981-46 (“To anyone * * * not

incorrigibly addicted to the ‘free lunch’ philosophy of life, the

entire scheme had to have been seen as a wholly transparent

sham.”).

Based upon the record in the instant case, we find that

petitioner’s actions do not approach the actions that a
reasonable and ordinarily prudent person would have taken under

the circumstances. Accordingly, petitioner is liable for the

addition to tax due to negligence for taxable year 1984.

Respondent is sustained on this issue.

Issue 6. Valuation Overstatement

Respondent determined that petitioner’s underpayment in 1984

is, in part, attributable to a valuation overstatement. Section

6659 provides for an addition to tax on an underpayment of $1,000

or more attributable to a valuation overstatement.

A valuation overstatement is defined to include a claim on a

return of a valuation of 150 percent or more of the correct

valuation. Sec. 6659(c); see Leuhsler v. Commissioner, 963 F.2d

907, 911 (6th Cir. 1992), affg. T.C. Memo. 1991-179. The amount

of the addition to tax equals the product of the applicable

percentage, as determined under section 6659(b), and the

underpayment of tax resulting from the overvaluation. Sec.

6659(a).1

We have determined that petitioner’s claimed investment tax

credit in 1984 was based upon a gross overvaluation of the

subject master. Petitioner claimed an investment tax credit

based on the master’s purported value of $496,000. We have

determined, however, that the master’s actual value equaled

1
Sec. 659 was enacted to discourage taxpayers from investing
in abusive tax shelters that rely on the significant
overvaluation of shelter assets in order to produce the desired
losses that serve to reduce the investors’ tax liabilities. See
H. Rept. 97-201, at 243 (1981), 1981-2 C.B. 352, 398.
$3,000 to $5,000. Accordingly, without further analysis, we find

that petitioner is liable for the addition to tax due to a

valuation overstatement under section 6659. Respondent is

sustained on this issue.

Issue 7. Increased Interest

Section 6621(c) provides for an interest rate of 120 percent

of the statutory rate where there is an underpayment of taxes in

excess of $1,000 attributable to one or more enumerated “tax

motivated transactions” in any year. The increased interest rate

applies to interest accrued after December 31, 1984, even though

the transaction was entered into prior to that date.

Solowiejczyk v. Commissioner, 85 T.C. 552 (1985), affd. without

published opinion 795 F.2d 1005 (2d Cir. 1986).

Tax-motivated transactions include valuation overstatements

within the meaning of section 6659(c). Sec. 6621(c)(3)(A)(i).

As we have determined that petitioner is liable for the addition

to tax due to a valuation overstatement, we sustain respondent on

this issue. Accordingly, we find that petitioner is liable for

the increased rate of interest under section 6621(c).

Issue 8. Penalty Under Section 6673

Respondent filed a motion in the instant case for a penalty

against petitioner under section 6673. Whenever it appears that

proceedings before this Court have been instituted or maintained

by the taxpayer primarily for delay, or the taxpayer’s position

in such proceedings is frivolous or groundless, or the taxpayer
unreasonably failed to pursue available administrative remedies,

section 6673 provides that the Court may require the taxpayer to

pay a penalty to the United States. As to positions taken after

December 31, 1989, in proceedings which are pending or commenced

after that date, the maximum amount of the penalty is $25,000.

Proceedings may be treated as instituted primarily for delay

where a taxpayer does not provide the Commissioner with

information or offer evidence at trial. Stamos v. Commissioner,

95 T.C. 624, 638 (1990), affd. without published opinion 956 F.2d

1168 (9th Cir. 1992). A position is groundless if the taxpayer

knew very well in advance of trial that there was no basis in law

or fact for the deductions he or she claimed. Horn v.

Commissioner, 90 T.C. 908, 946 (1988). If a taxpayer knew or

should have known that his or her position is without merit, a

court may and should impose sanctions. Coleman v. Commissioner,

791 F.2d 68, 71-72 (7th Cir. 1986). Unreasonable failure to

pursue available administrative remedies includes unreasonable

failures to respond to the Commissioner's requests to

substantiate deductions. Birth v. Commissioner, 92 T.C. 769, 774

(1989).

Wolf v. Commissioner, T.C. Memo. 1991-212, affd. 4 F.3d 709

(9th Cir. 1993), was the test case for taxpayers involved in the

Encore Leasing Tax Shelter Program. Petitioner was provided with

the opportunity to sign a stipulation agreeing to be bound by the

outcome in Wolf v. Commissioner, supra. Petitioner did not agree
to such stipulation. Respondent advised petitioner that if his

case were litigated, respondent would file a motion for a penalty

under section 6673. In Wolf v. Commissioner, supra, respondent

was sustained on all issues including the additions to tax and a

damage award under section 6673. Respondent argues that the

instant case is indistinguishable from Wolf, and as such, is

frivolous, meriting an award of damages under section 6673.

We have carefully considered the particular circumstances of

the instant case, and although we have found the lease

transaction to be devoid of economic substance, we do not find

petitioner’s position to be frivolous. We have determined that

petitioner lacked due care and did not take the steps an

ordinarily prudent person would have taken with respect to

claiming the deductions and investment tax credit attributable to

his investment in Encore; however, in the particular setting of

this case and exercising our discretion, we decline to award a

penalty under section 6673 in this proceeding. Accordingly,

respondent’s motion for a penalty under section 6673 is denied.

To reflect the foregoing,

An appropriate order and

decision will be entered.